The ATO’s Justified Trust Program and the Top 1,000

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The ATO's fifth findings report provides insights into the outcomes, evolution and nature of the Top 1,000 income tax and GST assurance program

4 December 2023

In Brief

In October 2023, the Australian Taxation Office (ATO) released its fifth findings report covering the Combined Assurance Review (CAR) program for the twelve months ended 30 June 2023. The CAR program applies to large public and multinational companies with turnover above $250 million, broadly referred to as the ‘Top 1,000’ taxpayers in Australia. The findings report provides interesting insights to the evolution and nature of the program and marks over six years of the ATO’s justified trust approach to obtaining tax assurance for Australia’s large public and multinational groups.

Whilst the focus areas of the ATO’s assurance reviews remain similar and the statistics have slowly shifted towards the overall objective of obtaining justified trust, questions still remain in relation to the outcome of the program to date and what is in store for Top 1,000 taxpayers in the future.

The overall goal of the co-operative compliance approach adopted under the Justified Trust program is to ensure that Australian taxpayers have paid the right amount of tax by encouraging a change in behaviours through transparency and governance (i.e., increased cooperation). In order to implement this method of tax compliance, there has been an increase in enforcement through detailed reviews, which is the opposite of what this type of compliance approach seeks to ultimately achieve. At some point, the enforcement and reviews should taper off and taxpayers should be able to demonstrate that they are compliant and paying the correct amount of tax by demonstrating good governance and providing updates on any significant changes to their business.

In this article we examine the journey to Justified Trust and also delve into the more notable findings and our experiences.

In Detail

Australian experience of CARs and Justified Trust

Justified trust is a concept developed by the Organisation for Economic Cooperation and Development (OECD) which is used by the ATO to build community confidence that taxpayers are paying the right amount of tax.

The ATO website states:

“To achieve justified trust, we seek objective evidence that would lead a reasonable person to positively conclude you have paid the right amount of tax. We need to obtain assurance over the whole of your business and economic activities connected or linked to Australia.”

When engaging with taxpayers to obtain Justified Trust, the ATO will generally focus on the following four key areas:

understanding a taxpayer's tax governance framework
identifying tax risks flagged to the market
understanding significant and new transactions; and
understanding why the accounting and tax results vary

The ATO applies the Justified Trust methodology to CAR reviews, which cover both income taxes and goods and services tax (GST). A CAR review can last anywhere between three months and six months , and may involve multiple rounds of engagement with the ATO.

Assurance ratings and their outcomes

The outcome of a Top 1,000 report is a rating of 'High Assurance’, ‘Medium Assurance’, ‘Low Assurance’ or ‘Red Flag’.

If overall assurance is obtained, then a ‘High Assurance’ or green light rating is provided to the taxpayer. The ATO has indicated that taxpayers that achieve justified trust can expect a tailored approach to subsequent reviews. In practice, as we are now seeing many ‘High Assurance’ taxpayers undergo a second review, there appears to be an expectation gap as between taxpayers and the ATO regarding what a tailored approach would look like.

Based on our experience to date, the second review that a ‘High Assurance’ taxpayer undergoes is very similar to that of a ‘Medium Assurance’ taxpayer or a new entrant into the program. That is, there does not appear to be substantial tailoring to the number or type of questions included in the review, or the generic nature of the review in general, with many questions that have no application to the specific taxpayer still being included in the questionnaire.

Arguably, a clearer articulation of the benefits of achieving the high assurance rating would benefit the trust building process and the robustness of a Justified Trust style program.

The role of governance

Tax governance is a key component of the Justified Trust methodology. Effective tax risk governance ensures that the financial, regulatory and reputational risks as they relate to tax matters are effectively identified and managed. The ATO’s Tax Risk Management and Review Guide follows the OECD’s guidelines on tax risk management. Broadly, the OECD view is that “The commitment of businesses to cooperate, to be transparent and to be tax compliant should be reflected in its risk management structures and policies”.

Since the introduction of the Tax Risk Management and Review Guide in 2017, the ATO has gradually moved the benchmark for its expectation of tax risk and governance. The current expectation to obtain a high assurance rating is to achieve at least a ‘Stage 2’ rating on tax governance, which requires a board endorsed testing plan to be in place. The reasoning for this gradual shift is presumably to reach a stage where the top 1,000 taxpayers in Australia are eventually in a position to independently test their tax compliance operations and present these findings to the ATO so that the need for a detailed review on a rolling four-year period diminishes.

Currently, whilst many taxpayers have been on the journey to implement, improve and bring to life their tax governance processes, others struggle to understand the investment and time required to implement these procedures and to bring their stakeholders - particularly those based overseas - on the journey.

‘Next Actions’

On the other corner of the Justified Trust landscape are taxpayers that have received a low or medium assurance rating, resulting in a ‘next action’ in some cases.

There is currently some uncertainty around the parameters and processes that govern a next action product, which is discussed further below.

Significant areas of review under the CAR

Transfer Pricing

Transfer pricing continues to be a key area of focus for the ATO given the complexity of cross-border arrangements. The ATO has published numerous transfer pricing-related guidance products and materials - including taxpayer alerts and practical compliance guidelines outlining key ATO focus areas and approaches to risk identification - to encourage changes in the behaviour of taxpayers as it relates to their tax compliance and strategy. These ‘tax risks flagged to market’ form a key focus of CAR and Top 100 reviews, and should be carefully considered by taxpayers (if not already covered as part of their Reportable Tax Position (RTP) schedule processes).

With respect to the ATO’s findings, the findings report outlines that broader ‘common issues’ that continue to arise in relation to transfer pricing matters include:

inadequate and non-contemporaneous transfer pricing documentation (and a lack of underlying evidence supporting key aspects of the transfer pricing position); and
material changes in transfer pricing policies without changes to the functional profile of the taxpayer and/or the selection of inappropriate transfer pricing methodologies.

While most taxpayers with a second review maintained their prior rating, the ATO cited the second point above as leading to a concerning trend of a number of taxpayers receiving a lower rating in subsequent reviews.

Specific arrangements of concern cited in the findings report include:

Licence fees and royalties - focused on the ability to evidence benefits obtained from licenced assets and the implications of Australian DEMPE (Development, Enhancement, Maintenance, Protection and Exploitation) activity relating to intangibles. This area resulted in the highest proportion of low assurance ratings (non-financing related).
Inbound and outbound supplies of goods and services - focused on distribution arrangements and the ongoing presence of high-risk disclosures made in the RTP schedule for these arrangements.
Financing - focused on a range of financing arrangements, including interest bearing loans, cash pooling and interest free loans. Notably, financing had a higher proportion of low and red flag assurance ratings than other assurance areas reviewed, with the most common arrangements that attracted low or red flag ratings related to interest bearing loans, redeemable preference shares, cash pooling and convertible notes.

Importantly, about 40 per cent of the ATO’s next actions audits escalated either directly from a Top 1,000 review or from a next actions review, include transfer pricing issues. This figure excludes financing (which attracts a relatively higher number of low assurance ratings), so total next actions reviews or audits involving transfer pricing matters are likely to be significantly higher.

About 40% of next actions audits included transfer pricing issues, not taking into account financing matters which tend to attract lower assurance ratings.

The typical 28-day turnaround time for information requests can place significant pressure on company resources and a failure to prepare can lead to detrimental outcomes. To help manage this, there are a number of proactive steps taxpayers can take in preparing for a CAR from a transfer pricing perspective, including:

Consider the typical CAR questions published by the ATO and ensure you are able to respond.
Ensure that transfer pricing documentation with appropriate economic analysis (and underlying source evidence) required to substantiate your position is available. Notably, the years covered under the latest round of CAR activity may also include income years impacted by the COVID-19 pandemic, which may have had an abnormal impact on transfer pricing positions during this period and thus require further analysis and consideration of previously released ATO guidance.
Consider and come prepared to support any non-‘low risk’ positions in relation to the ATO’s tax risks flagged to market. For example, under Practical Compliance Guidelines relating to financing arrangements (PCG 2017/4) and/or inbound distribution arrangements (PCG 2019/1).
Consider any ATO recommendations stemming from a prior (completed) CAR or earlier Top 1,000 review.
Monitor the publication and finalisation of ATO guidance (e.g., PCG 2023/D2 - Intangible Arrangements), which will be the subject of future CAR activity and retain evidence to support any arrangements within the scope of these.

Hybrid mismatch rules

For many taxpayers, 2023 was the first year the full scope of the hybrid mismatch rules needed to be considered.

The hybrid mismatch rules are relatively new, first applying to income years starting on or after 1 January 2019, and 1 January 2020 for the complete imported mismatch rule. As such, it was only recently that CARs began to cover income years when the full scope of the hybrid mismatch rules was in effect.

This is reflected in the ATO findings, which revealed that in 2023, only 28 per cent of taxpayers reviewed had a hybrid mismatch area of assurance reviewed, compared to 14 per cent in 2022.

As for ratings, 26 per cent of taxpayers received a low assurance rating, with only 35 per cent receiving a high assurance rating and 38 per cent a medium assurance rating.

The ATO identified two common concerns as contributing to low assurance ratings:

no evidence of any substantial efforts made to comply with obligations in respect of the hybrid mismatch rules, and in particular, the imported mismatch rule; and
actual or potential risk of hybrid mismatch was identified.

The ATO also identified inadequate evidence to support the processes and procedures taxpayers are undertaking to ensure compliance with the imported mismatch rule as the key factor contributing to a medium assurance rating.

The findings indicate that these hybrid mismatch rules will continue to be an area of focus for the ATO. This reinforces the broader theme that cross-border transactions contribute to lower levels of assurance.

Some key takeaways for taxpayers are:

The imported mismatch rule is the common denominator when it comes to low or medium ratings, which is not surprising given this is where taxpayers generally require information from their broader global group to determine their position.
Taxpayers should ensure they have fully documented and substantiated their positions in accordance with the approach set out in Practical Compliance Guideline PCG 2021/5. This should be done contemporaneously with preparation of the tax return.
Where the (non) application of the imported mismatch rule is dependent on foreign tax outcomes or treatments, the foreign tax position should be appropriately analysed and documented.

Governance

In their first Top 1,000 review, the majority of taxpayers received a Stage 1 governance rating, indicating that a tax control framework exists. Of those taxpayers that had a second review, 48 per cent gained a rating of Stage 2, which requires a board endorsed testing plan to be in place.

The ATO noted some common issues that have led to taxpayers falling short of a Stage 2 rating:

global tax policies or enterprise-wide policies that are too general in nature and do not specifically address Australian tax governance
commitments to undertake periodic internal testing has not been evidenced in the Tax Governance Policy
a lack of detail in the documented procedures to support the process for the preparation or review of the tax return or for reconciling the tax calculation from the financial statements to the completed return; and
board reporting templates that do not include minimum matters, which should be escalated to the board.

Some suggestions to assist with preparing for a CAR from a governance perspective are:

improve the tax governance framework (especially for a second review)
review the common shortfalls in achieving a Stage 2 rating – what may have been accepted on a first round review is unlikely to meet the ATO’s current expectations; and
consider the minimum requirements for your documentation if undergoing a first time review.

Separately, with the anticipated Public Country-by-Country Reporting (PCBCR) measures coming soon, taxpayers will be required to publicly release a description of the group’s ‘approach to tax’ and may wish to consider providing additional information to contextualise PCBCR disclosures. Improvements to tax governance frameworks should appropriately encompass these requirements, and taxpayers may wish to review existing CBCR disclosures in advance of the PCBCR measures being enacted. This exercise may also assist in evaluating whether the CBCR is a ‘qualifying CBCR’, which is a necessary eligibility requirement to satisfy the Pillar 2 transitional safe harbours.

GST

There has been an increase in taxpayers obtaining an overall high assurance outcome as at their most recent review, rising from 26% last year to 31% this year. According to the ATO, this has been primarily attributable to more taxpayers achieving a stage 2 rating for governance, something required to obtain an overall high assurance rating.

Notwithstanding the above, the majority of taxpayers obtained an overall medium assurance outcome (69% this year versus 65% last year), with this being primarily as a result of obtaining a stage 1 rating for GST governance.

The ATO identified the following as key GST risk areas that result in corrections to returns and lower assurance ratings:

Financial supplies: monitoring the Financial Acquisitions Threshold, the availability of Reduced Input Tax Credits, and the application of the reverse charge provisions to cross-border transactions.
GST classification: monitoring the GST treatment of products sold by retailers, including food and health products.
Property: monitoring the GST treatment of sales, transfers, and leases for construction and development businesses (e.g., the margin scheme, short-term accommodation, residential premises).
Recipient Created Tax Invoices (RCTIs): whether valid RCTI agreements are in place and whether suppliers with no GST registration have been issued RCTIs.
International GST risks: whether related offshore entities are liable to remit GST because of the sale of digital products and services or low-value goods, or electronic distribution platforms.

GST governance continues to be a core focus of the ATO, and the clear expectation is that taxpayers should continue to develop their GST risk management processes and are at a stage 2 rating before an overall high assurance rating can be achieved. To do this, we recommend undertaking some form of internal and/or external review to confirm controls are comprehensively documented and any gaps rectified, including:

control testing procedures (including any data and transaction testing)
BAS preparation processes; and
reconciliation processes between the BAS and audited financial statements (e.g., with the assistance of the GST Analytical Tool).

For those taxpayers that have received a prior review and are still within the Top 1,000 population, we recommend reviewing the findings report from their previous review to identify any next actions and recommendations that were made by the ATO as part of the first review. Taking action on any of these items could mean an increase in the rating received on a second review and a smoother experience during any future ATO engagement.

Other Domestic Tax Considerations

The key behaviours that are now becoming the expected ‘norm’ in relation to loss utilisation include:

preparation of detailed workpapers, contemporaneous documentation and tracing back to underlying evidence that supports the continuity of ownership and business continuity tests as relevant
transfer of losses - Preparation of Available Fraction calculations that are supported by market valuations, and also capture capital injection events; and
ensuring adequate historic information that contextualises and evidences the origination or source of the losses.

If you have capital or revenue losses, we recommend checking that you are meeting the requirements above and considering if your tax compliance processes are sufficiently adequate, and whether sufficient supporting documentation is prepared in ‘real time’ to lessen the burden of preparing for Justified Trust reviews.

The ATO has previously flagged tax consolidation as an area that continues to be examined closely due to its inherent complexity. Some of the more common areas noted by the ATO as tripping up taxpayers are related to the allocable cost amount (ACA) calculations and include a lack of documentation (i.eThe ATOexpects clearly presented ACA calculations with supporting market valuations and technical analysis), omission of transaction costs in Step 1 of the entry ACA and incorrectly spreading cost base to intangible assets. These matters could mean the difference between a high assurance rating and a medium rating.

As the above is now a minimum expectation, the ATO’s focus has shifted to specific scenarios, such as restructures that use the consolidation regime for various advantageous purposes, and inversions or the use of eligible tier-one companies, amongst other things. If you have any fact patterns that involve any of these examples, we recommend reviewing your positions and documenting them.

When assessing capital allowances, particular attention has been paid by the ATO to governance processes and systems that taxpayers have in place.The ATO identified the following as the main areas that resulted in a lower assurance rating:

inadequate documentation to support self-assessed effective lives of Division 40 depreciating assets and disclosure errors in tax returns
incorrect asset classification and deductions claimed in relation to Division 40 and Division 43 capital works
capital improvements versus repairs and maintenance; and
incorrect low-value pool deductions.

Our experience is that automation tools have been, and continue to be, an effective way to review and understand whether the tax fixed asset register is functioning well and picking up on any potential errors if fixed assets are an area of concern. The ATO have responded positively to automation of fixed assets and tax processes more generally as they are a desirable control and included in ATO guidance (Managerial Level Control 4 Per the ATO Tax Risk Management & Governance Review Guide).

Where taxpayers have received medium assurance, the issues flagged were:

concerns around the rollover exemptions or reductions
market valuations supporting the cost base of assets (such as goodwill and intangible assets)
active foreign business asset exemption (Subdivision 768-G); and
the calculation (or evidence) of proceeds and insufficient evidence to support the CGT calculation.

Similar to other areas, the main issue flagged appears to be evidence, especially in areas where there is complexity.

The majority of taxpayers that had a R&D claim received a medium assurance rating (60 per cent). This is not surprising given the ATO’s focus on R&D claims in the recent past and the release of a series of taxpayer alerts. A small proportion received low (12 per cent) and high ratings (28 per cent).

Based on the ATO’s findings, it would appear the key takeaways for taxpayers with R&D claims are:

to improve governance processes in respect of R&D expenditure - for example, documented clear controls related to capturing R&D spend that is eligible for the R&D claim; and
track, document and evidence the nexus of expenditure to the R&D activities.

Practical outcomes of next actions and next steps for reviews

Taxpayers who have follow up actions/recommendations or red flags/low assurance items included in their CAR/SAR are at risk of further ATO engagement. This is especially relevant to those taxpayers who have low assurance/red flags or recommendations/red flags in the following areas:

transfer pricing
taxpayer alerts, or other risk areas flagged to market
inbound supplies of goods/services
financing; and
restructures and acquisitions.

Taxpayers selected for further ATO engagement may be subject to an array of ATO products from a ‘lighter touch’ follow up engagement to a full length audit (where appropriate), depending on the risks identified and the ATO’s view of the likelihood of resolution of the matters identified.

In our experience, the ATO is likely to move the engagement to a detailed risk review or an audit where the taxpayer does not materially adopt the ATO’s preferred approach to the identified risk. In these engagements, to the extent that the ATO is considering the application of the anti-avoidance provisions, the ATO is increasingly using their formal powers, whether or not the engagement has proceeded to an audit.

In addition, the ATO is increasingly adding consideration of the deductibility of Share Based Compensation recharge payments to audits and risk reviews, especially for inbound distributors.

Where taxpayers are selected for further ATO engagement, the ATO’s information requests will likely be extensive, and taxpayers should be aware that if they are selected for a Next Actions engagement, the ATO team dealing with this Next Action engagement will be a different team to the CAR team. Additionally, during this further ATO engagement, the new ATO team can use any of the other ATO specialist teams (e.g., Economist Practice and Tax Counsel Network) to support their review/audit. Contemporaneous evidence supporting your positions continues to be important to a successful engagement with the ATO in a risk review or audit.

A number of observations in the findings report refer to first time reviews, which have generally received lower ratings than their ‘top up’ review counterparts. A potential reason for this flagged by the ATO is that new entrants to the program may not have the familiarity with the comprehensive nature and expectations of the program.

The Takeaway

The Top 1,000 program will continue into the foreseeable future with Government funding extended and second reviews for taxpayers already in motion.

Whilst the expectations of good tax governance will increase, it appears that the ATO is not at the stage yet where they can move away from the ‘enforcement’ stage of Justified Trust, so detailed reviews will continue.

Following on from the findings report, there are some tangible and practical steps that taxpayers can take to elevate the experience with the ATO, as well as their ratings. These steps include:

If you are subject to a first time review, potentially seek consultation on the comprehensive nature of the CAR and the expectations on the level of evidence required so as not to risk a lower rating due to providing insufficient responses or evidence.
Review your Transfer Pricing arrangements and identify any that may have had material changes, or where the documentation in place is not contemporaneous or adequate.
Review hybrid mismatch arrangements and documentation to support positions taken in your tax returns. Ensure that documentation is aligned with the ATO’s practical guidance.
Review your governance documentation. If you have been reviewed previously, check that progress has been made from where the ATO rated you in the prior review period. If you are new to the program, ensure that you have sufficient documentation in place to support the desired outcome/rating.
Review significant transactions - ensure that sufficient documentation exists in relation to capital gains/losses and consolidation. Potentially speak to your adviser about documentation of significant transactions procedures and controls.
Review recent ACA calculations and confirm that documentation has been prepared to support valuations where they are needed.
Ensure that you have sufficient documentation in place to support the generation and the utilisation of losses (under the continuity of ownership test or business continuity test).
Review your R&D claims, ensure that you have sufficient detail and evidence to support claims. Speak to your adviser about putting more documentation/process documents in place if needed.
Review and update your GST controls and process documentation to ensure it has sufficient detail surrounding control testing procedures, BAS preparation processes, and relevant reconciliation processes to identify and understand variances between accounting figures reported in your audited financial statements and the annualised GST figures reported on the BAS.

Contact us

If you would like to further discuss this alert, reach out to our team or your PwC adviser.

Sarah Saville

Partner, Tax Reporting and Innovation, Sydney, PwC Australia

+61 421 052 504

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Chris Vanderkley

Special Counsel, Melbourne, PwC Australia

+61 412 170 744

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Edin Mahir

Partner, Global Tax, Sydney, PwC Australia

+61 415 931 934

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Sam Lavender

Director, PwC Australia

+61 2 8266 2913

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Angela Danieletto

Partner, Tax, Sydney, PwC Australia

+61 410 510 089

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Nick Maley

Partner - Tax Controversy, PwC Australia

+61 413 617 775

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Mark Simpson

Partner, Tax, Sydney, PwC Australia

+61 (2) 8266 2654

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The ATO’s Justified Trust Program and the Top 1,000

The ATO's fifth findings report provides insights into the outcomes, evolution and nature of the Top 1,000 income tax and GST assurance program

Australian experience of CARs and Justified Trust

Assurance ratings and their outcomes

The role of governance

‘Next Actions’

Significant areas of review under the CAR

Transfer Pricing

Hybrid mismatch rules

Governance

GST

Other Domestic Tax Considerations

Practical outcomes of next actions and next steps for reviews

Contact us

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